A cut in treatment and refining charges (Tc/Rc) is staring copper smelters Hindalco Industries Ltd and Vedanta Ltd in the face. Last week, Reuters reported that Freeport-McMoran Inc. got a 5% cut in the fees it will pay to China’s Jiangxi Copper Corp. to process copper concentrate in 2017. This is the second successive year that it has been cut and will set the benchmark for negotiations in the region, said Reuters. In 2016, these Tc/Rc fees were set at $97.35 per tonne, 9% lower than the previous year, and are now set at $92.50 per tonne for 2017, using the Freeport deal as a benchmark.

Custom smelters buy copper concentrate from mining companies and process them. In turn, they earn fees which represent their main source of profits and not the market price of copper. In addition, by-products such as sulphuric acid too earn them revenue. However, even acid prices have been soft in FY17. When the concentrate market is oversupplied, custom smelters have an upper hand as miners run after buyers. The opposite situation prevails when the market turns tight.

Aurubis AG, a large custom smelter, called these fees too low, reflecting unfounded short sentiment, said another article by Reuters. Smelters believe that more concentrate supply will come to the market later in the year, which may see spot prices increase. However, long-term contracts may prevent them from benefiting from any increase in spot prices.

In its conference call after its September quarter results, Hindalco Industries management had indicated it was hopeful of fees either staying flat or slightly higher. The company buys 90% of its requirement through long-term contracts and the rest from the spot market. Another domestic company that runs a copper smelter is Vedanta, which said it had seen these fees decline since the start of the year, affecting profitability.

The cut in 2017 fees is a sign that the copper business of these companies may face some pressure on the profitability front in FY18. Higher volumes may be one way of getting over the difficult situation. On the bright side, Hindalco’s aluminium business should be in a position to support its performance, while Vedanta has a number of businesses, including aluminium and zinc, to offset tougher conditions in the copper market.

Both stocks had been doing well as China’s renewed appetite for metals has seen a rally in both metal prices and shares of their producers. Of late, there has been a pull-back, with Vedanta’s shares down around 14% since 11 November, while Hindalco’s shares were down by over 8% in this period.